“Smart Money” Can Be Equally Clueless

The Straits Times Index (SGX: ^STI) closed Monday’s (23 June 2013) session at 3,074, representing an 11.3% slide from its 52-week high of 3,465 set slightly more than a month ago on 22 May 2013. Participants in the stock market must be wondering if there might have been some stock market oracles that were predicting a top in the index at that exact moment. While I can’t plausibly scour the entire spectrum of financial media, I would think it’ safe on my part to wager that nobody got it right – and for those who did, congratulations. Now,…

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The Straits Times Index (SGX: ^STI) closed Monday’s (23 June 2013) session at 3,074, representing an 11.3% slide from its 52-week high of 3,465 set slightly more than a month ago on 22 May 2013. Participants in the stock market must be wondering if there might have been some stock market oracles that were predicting a top in the index at that exact moment.

While I can’t plausibly scour the entire spectrum of financial media, I would think it’ safe on my part to wager that nobody got it right – and for those who did, congratulations. Now, let’s see if they’re any good at picking the bottom for the STI’s current fall. The thing is, it’s really hard to time the market consistently, i.e. to predict exactly when it’ll rise and fall.

It’s one thing to make a statement saying ‘timing is close to impossible’, and another to see it in action. Yale’s School of Management publishes a Crash Confidence Index (CCI) where institutional investors and wealthy individual investors are polled on their confidence that the market won’tcrash in the next 6 months. The higher the CCI, the more likely market participants think a crash is unlikely.

I took the CCI data and plotted it against the S&P 500 Index’s (a broad stock market index for the US market) monthly performance. Here’s the chart below, which brought home two key messages for me.

Message 1: It’s hard to get market timing right consistently

Individual and institutional investors got it right that the market might be peaking when the CCI for both groups dropped in August 2007, suggesting that they were worried the market might fall within the next six months. Turns out, the market did crash and only found a bottom in March 2009.

But, that’s when it gets interesting. At the market’s bottom on March 2009, both group’s confidence levels were at the lowest since July 2001 – i.e. they probably thought subsequent market crashes after March 2009 would be a given. Turns out, the S&P 500 went on to rally spectacularly.

It’s one thing to get a particular call right, but another to get it consistently right. After all, even a broken clock can show the correct time twice a day.

Message 2: “Smart money” isn’t as smart as you think they are

Institutional investors are often taken to be “smart money”, since they handle vast sums of money and are said to be better at be able to foresee the direction of markets. But, from the chart, it does not seem to be the case.

The ‘smart money’ weren’t any better at fore-telling market crashes and missed the subsequent rebound by having a lot more confidence in an upcoming crash, just as the market rebounded sharply in 2009.

Simply said, the institutional investors were equally clueless, compared to the individual investors.

Foolish Bottom Line

We can’t predict what the markets will do with consistency – nobody can, not even the ‘smart money’. So let’s not waste our time listening to prognosticators, pundits and soothsayers. Instead, let’s spend time and effort in identifying great businesses selling at discounts to their intrinsic values. That’s what Foolish investors do.

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